Budget 2021: Government to set up 'Bad bank' to face NPAs

In the 2021 budget, Finance minister Nirmala Sitharaman announced an Asset Reconstruction Company Limited and Asset Management Company to manage the forecasted record level of bad debts for banks. These financial institutions will be responsible for consolidating and taking over the stressed debts and disposing these assets to Alternative Investment Funds and other potential investors for eventual value realisation.

The latest Financial Stability Report released by Reserve Bank of India forecast that gross Non-Performing Assets (NPAs) of banks might increase from 7.5 per cent of September 2020 to 13.5 per cent in September 2021 under the baseline scenario. Shaktikanta Das, the Governor of the Reserve Bank of India, had indicated earlier that to tackle Non-Performing Assets (NPAs), the central bank could look into the idea of a 'Bad Bank' if there is a proposal for it.

What is a bad bank?

Bad banks are typically set up in times of financial crises to enhance banks' and other financial institutions' health. It need not be a single entity, and can also be a group of institutions. An Asset Reconstruction Company (ARC) or Bad bank divides assets into two categories; healthy assets that will contribute to banks' growth, while the second category comprises non-performing assets and risky liabilities. Bad banks take over the burdens of this second category.

The primary benefit expected from setting a bad bank is the assurance of banks' long-term well-being for raising capital, borrowing, and lending money. Also, healthy assets and risky ones will stay separate without mixing.

Responses to Budget announcement

All India Bank Employees Association (AIBEA) has expressed disagreement with forming bad banks and commented that the move only means removing strain from books. "Bad Loans and NPAs in the banks have been increasing year after year because of corporate defaulters. Instead of taking tough action on them, the Government wants to whitewash the balance sheets by shifting these bad loans from the banks' books to the Bad Bank," they said.

In a report from The Hindu on January 30, the Chief Economic Advisor Krishnamurthy Subramanian evaluates the functioning of a bad bank in the private sector as more efficient than in the public sector because quick decision making does not happen very well in the public sector.

Bad banks have also been criticised for encouraging banks to take undue risks.